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MS Trucking is considering the purchase of a new piece of equipment that has a net initial investment with a present value of $300,000. The equipment has an estimated useful life of3years. For tax purposes1 the equipment will be fully depreciated a rates of 30%, 40%, and 30% in years one, two, and three, respectively. The new machine is expected to have a $20,000 salvage value. The machine is expected to save the company $170,000 per year in operating expenses. MS Trucking has a 40% marginal income tax rate and a 16% cost of capital. Discount rates for a 16% rate are:


What is the profitability index for the project?

  1. 1.089
  2. 1.106
  3. 1.315
  4. 1.063

Answer(s): A

Explanation:

The profitability index is the present value of the future net cash inflows divided by the present value of the net initial investment. The present value of the future net cash inflows is $326,556. Hence, the profitability index is 1.089 ($326,556 $300,000).



View Related Case Study

MS Trucking is considering the purchase of a new piece of equipment that has a net initial investment with a present value of $300,000. The equipment has an estimated useful life of3years. For tax purposes1 the equipment will be fully depreciated a rates of 30%, 40%, and 30% in years one, two, and three, respectively. The new machine is expected to have a $20,000 salvage value. The machine is expected to save the company $170,000 per year in operating expenses. MS Trucking has a 40% marginal income tax rate and a 16% cost of capital. Discount rates for a 16% rate are:


The payback period for this investment is

  1. 2.84years.
  2. 1.76years.
  3. 2.O8years.
  4. 3.00 years.

Answer(s): C

Explanation:

The payback period is the time required to recover the original investment. The annual net after-tax cash inflows for Year 1 through Year 3 are $138,000, $150,000, and $150,000, respectively, as determined by the following: In Year I, the after-tax cash inflow is $170,000 minus taxes of $32,000 {[$1 70,000 -- ($300,000 x 30%) depreciation] x40%}, or $138,000. In Year 2, the after-tax cash inflow is $170,000 minus taxes of $20,000 {[$1 70,000 -- ($300,000 x 40%) depreciation] x 40%}, or $150,000. In Year 3, the after-tax cash inflow (excluding salvage value) is again $138,000. After2years, $288,000 ($138,000 + $150,000) will have been recovered. Consequently, the first $12,000 received in Year 3 will recoup the initial investment. Because $12,000 represents .08 ofYear3 net after-tax cash inflows ($12,000 + $150,000), the payback period is 2.09 years.



View Related Case Study

MS Trucking is considering the purchase of a new piece of equipment that has a net initial investment with a present value of $300,000. The equipment has an estimated useful life of3years. For tax purposes1 the equipment will be fully depreciated a rates of 30%, 40%, and 30% in years one, two, and three, respectively. The new machine is expected to have a $20,000 salvage value. The machine is expected to save the company $170,000 per year in operating expenses. MS Trucking has a 40% marginal income tax rate and a 16% cost of capital. Discount rates for a 16% rate are:


Assume that the salvage value at the end of the investment's useful life is zero. What is the new payback period?

  1. 2.84years.
  2. 1.76years.
  3. 2.08 years.
  4. 2.09 years.

Answer(s): D

Explanation:

The payback period is the time required to recover the original investment. As determined below, the annual net after-tax cash inflows for Years 1 through 3 are $138,000, $150,000, and $138,000 (excluding salvage value), respectively. In Year 1, the after-tax cash inflow is $170,000 minus taxes of $32,000 {[$1 70,000 -- ($300,000 x 30%) depreciation] x 40%}, or $138,000. In Year 2, the after-tax cash inflow is $170,000 minus taxes of $20,000 {[$1 70,000 -- $300,000 x 40%) depreciation] x 40%}, or $150,000. In Year 3, the after-tax cash inflow I(excluding salvage value) is again $138,000. After 2 years, $288,000 ($138,000 + $150,000) will have been `recovered. Consequently, the first $12,000 received in Year 3 will recoup the initial investment.
Because $12,000 represents .09 (rounded) of Year 3 net after4ax cash inflows ($12,000 + $138,000), the payback period is 2.09 years.



View Related Case Study

MS Trucking is considering the purchase of a new piece of equipment that has a net initial investment with a present value of $300,000. The equipment has an estimated useful life of3years. For tax purposes1 the equipment will be fully depreciated a rates of 30%, 40%, and 30% in years one, two, and three, respectively. The new machine is expected to have a $20,000 salvage value. The machine is expected to save the company $170,000 per year in operating expenses. MS Trucking has a 40% marginal income tax rate and a 16% cost of capital. Discount rates for a 16% rate are:


What is the net present value of this project?

  1. $3,278
  2. $5,842
  3. $(568)
  4. $30,910

Answer(s): B

Explanation:

The NPV is the excess of the present values of the estimated net cash inflows over the net cost of the investment ($160,000). The future cash inflows consist of $85,000 per year savings minus income taxes. Given salvage value of $10,000, the depreciable base is $150,000 ($160,000 cost -- $10,000). The first and third years' depreciation deduction is $45,000 ($150,000 x 30%), leaving $40,000 ($85,000--$45,000) of taxable income. Thus, first- and third-year tax expense is $16,000 ($40,000 x 40%). Accordingly, the net cash inflow in both the first and third years is $69,000 ($85,000 --$16,000). The $60,000 ($150,000 x 40%) depreciation deduction in the second year results in $25,000 ($85,000--$60,000) of taxable income. Second-year tax expense is therefore $10,000 ($25,000 x40%) and the second-year net cash inflow is $75,000 ($85,000--$10,000). The net cash inflow from sale of the machine is $10,000. No tax is paid on this amount because the remaining book value is also $10,000. The present value of these net cash inflows is determined using the appropriate PV of $1 factors for a hurdle rate of 16%. Hence, the net present value is $5,842 ($165,842 PV--$160,000 cost).






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